Wisdom Education faces testing time as it launches IPO

Southern China's largest private school operator sets Hong Kong IPO despite uncertainty over China's educational structure and future tax structure.
Pupils at Wisdom's Dongguan Guangming School
Pupils at Wisdom's Dongguan Guangming School

Wisdom Education launched an initial public offering on Thursday, hoping to become the third Chinese private sector education operator to list on the Hong Kong Stock Exchange.

The group has picked a tricky time to access the market with its HK$850 million to HK$1.14 billion ($110 million to $147 million) transaction as the Chinese education sector is undergoing an uncertain transition.

Last November, the government promulgated a new education bill, which analysts hailed as a crucial step to shape the long-term structure of the Chinese educational sector.

However, the exact dimensions have yet to be spelled out and particularly the financial impact on private school providers.

This has hit existing listed comparables Virscend Education and China Maple Leaf Educational Systems, which have both been on a downward slide since July and August respectively.

Virscend did shoot back up again in mid-November, but its shares underwent a precipitous fall this Thursday, sliding 9.23% over the course of the day to close at HK$4.23. They are down 23.37% on a year-to-date basis.

One fund manager told FinanceAsia that syndicate sales desks have been warning investors not to use the company as a comparable because of corporate governance issues.

Last May, Hong Kong's Securities & Futures Commission (SFC) urged investors to use "extreme caution" with Virscend because the chairwoman, her husband, his daughter and a clutch of IPO investors held 95.52% of the shares between them.

Yet even at HK$4.23, Virscend is still trading at 22 times forward earnings according to CICC research forecasts. 

This is a big premium to China Maple Leaf, which is trading around the 16.5 times level on a forward consensus basis.

The stock also fell 2.65% on Thursday. Year-to-date it is down 7%, but is up 49.6% on a one-year basis. 

Wisdom is pitching itself at a discount to Maple Leaf - a function of both uncertain sector fundamentals and the fact that it is not as large or as profitable.

A 500 million share base deal is being marketed at HK$1.70 to HK$2.28 per share. This represents a 2017 P/E range of 12.1 to 15.2 times 2017 earnings pre greenshoe. 

Unusually, the deal has no cornerstone investors, but it does have the standard 90/10 institutional/retail split.

Bankers said demand is coming in at the bottom to roughly two-thirds of the way through the range. 

When does non-profit generate profit? When it’s a school..

They also said making comparisons between Maple Leaf and Wisdom is complicated by the fact they are two quite different animals. 

The former has a string of international schools and operates a VIE (variable interest entity) structure, usually adopted to allow for foreign investment in sensitive sectors in China, including education. That should enable it to retain its non-profit status and continue harvesting management fees under the new educational regime.

Wisdom does not have a VIE structure, but is also applying to be as classified as non-profit - a confusing term, which does not mean it cannot generate net income.

Back in November, the government announced only non-profit private schools would be able to offer classes for the nine compulsory school years.

However, the tax implications are not clear and neither is the relationship non-profit schools will have with local governments.

As SWS Research noted: "The current profit sharing model between private operators and local government for the establishment of new schools may be terminated."

Instead, the Chinese brokerages said there might be a new model may emerge "whereby local governments charge rental fees to provide buildings and land usage rights".

Syndicate analysts are assuming tax rates of 17% to 23% will be applied, but still believe Wisdom can achieve a net earnings CAGR in the high teens over the next three years.

In addition to expanding its network by one school per year, the group is also hoping to boost profitability further by bringing services such as catering in-house.

Wisdom is the largest private sector educational provider in Southern China with five schools: three in Dongguan and one in Huizhou, Guangdong province, plus a school in Liaoning province and a new school, which opened last autumn in Shandong province.

Since it opened its first school in 2003, it has grown to roughly 30,000 students at the end of 2016 compared to China Maple Leaf’s 20,500.

But it reported net profit of Rmb118,926 million in the nine months to September 2016 compared to Maple Leaf’s Rmb274 million for the entire 2016 financial year. As of September it was achieving a 22% net profit margin.

Wisdom has told investors it wants to continue expanding in western regions of the Pearl River Delta and has entered into co-operation agreements with local governments in Yunfu, Guangdong province and Guang’an, Sichuan province.

One of the metrics it most prides itself on is a 94.8% entry rate to university, with 21.4% of its students entering China’s top 20 universities.

The order book will close on January 19, with listing scheduled for January 26. Pre-shoe the company will be issuing 25% of its enlarged share capital, all through primary shares.

Clearly the company hopes investors will be able to see beyond weak sentiment as the private education sector is one, which many favour over the long-term thanks to its expansion potential and the stickiness of its earnings since pupils tend to stay put for the duration of their education.  

BNP Paribas is sole sponsor for the IPO. Joint global co-ordinators are BOC InternationalCiti, CLSA and CMB International, while joint bookrunners are ABC InternationalCCB InternationalHaitong International and Ping An Securities.

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